Pre-MPC Note: Policy Rates to Remain Stable as the CBN Takes the Unconventional Route

In the upcoming meeting of the Monetary Policy Committee (MPC) of the Central Bank of Nigeria (CBN) between July 22nd and 23rd 2019, we expect rates to be kept at current levels but the tone of members to support monetary easing. Since the last meeting in May 2019, the global and domestic economic environments have become more supportive of the shift towards looser monetary policy. On the domestic scene, the CBN has issued new guidelines to compel commercial banks to expand credit. The most drastic was the minimum floor of 60.0% established for loan to deposit ratio. Similarly, the maximum limit on deposits attracting interest at the Standing Deposit Facility window of the CBN was reduced from N7.5bn to N2.0bn per day. We do not expect these policies to significantly boost credit and drive a faster economic expansion in the absence of fiscal reforms.

Weak Global Growth Prospects Drive Monetary Easing
Ongoing global trade tensions continue to hit hard, prompting a shift towards monetary stimulus and rate cuts in advanced economies. The presidents of US and China reached a truce in June 2019 as the former promised to lower restrictions on Huawei in exchange for more agriculture exports to China. However, progress has been slow, with the US planning to expand the size of Chinese goods affected by tariffs. In response to a slowdown in growth, the US Fed signaled a likely rate cut at its next Federal Open Market Committee (FOMC) meeting.  Similarly, in the eurozone where inflation data for June 2019 came in at 1.3%, shy of the European Central Bank (ECB)’s target rate of 2.0%, we expect continued monetary stimulus. This provides the room for easing in emerging and frontier markets without significant risks to foreign portfolio investment.

Easing on Course Despite Weak External Balance
Since the last MPC meeting, two key datapoints indicate sustained weakness in Nigeria’s external position. The current account deteriorated to-1.0% of GDP in Q1:2019 from 1.0% in Q4:2018 due mainly to a weakened trade surplus as imports expanded faster than exports, reduction in remittances and sustained weakness in the income and services account. On a positive note, foreign capital flows expanded 34.6% Y-o-Y to US$8.5bn in Q1:2019, supporting the overall external account. Noticeably, foreign investors continue to be attracted to the debt market, but shunned equities as well as foreign direct investment. We do not expect this data to dictate the pace of monetary policy due to monetary easing in the global economy. We believe the CBN would continue its ongoing monetary easing in the fixed income market as higher liquidity levels support continued moderation in yields.

Sustained disinflation also supports the easing rhetoric of the CBN. Headline inflation rate moderated to 11.2% Y-o-Y in June 2019 from 11.4% in the previous month, although we attribute this to a high base effect as headline inflation was little changed at 1.1% M-o-M. Food inflation moderated to 13.6% Y-o-Y from 13.8% in the previous month and this was also driven by a high base effect as the increase of 1.4% M-o-M remains strong. We expect sustained pressure on food prices until the harvest season. On a comforting note, the sustained decrease in core inflation continued in June, with a deceleration to 8.8% Y-o-Y from 9.0% in the previous month. The increase of 0.9% M-o-M from 0.8% in core inflation was however slightly concerning. 

MPC to Maintain Status Quo on Policy Rates
Based on our analysis of recent issues, we believe the MPC would maintain status quo on all policy rates in the next meeting – (MPR) at 13.5%, Cash Reserve Ratio (CRR) at 22.5%, Liquidity Ratio at 30.0% and asymmetric corridor at +200 and -500bps around the MPR. We note that monetary easing is already on course in the debt market as the MPR is only symbolic. We expect the CBN to continue to ease by guiding yields downward through its less aggressive liquidity management operations.  Recently, we have observed a decline in the frequency of OMO sales by the CBN as 14 OMO sales were held in January relative to 2 sold June 2019. With a focus on exchange rate as the key monetary policy anchor, we believe downside risks are limited due to a strong external reserves balance, rising oil prices, improving oil production and monetary easing by systemically important central banks. We rule out the possibility of an interest rate hike as risks to inflation remain moderate and concentrated on the supply side.